An Energy-Stock Wizard's Latest Picks

By

Miriam Gottfried

Updated May 17, 2011 12:01 a.m. ET

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Investors can make a lot of money by successfully handicapping energy prices on a short-term basis. But veteran energy-stock picker Dan Rice says he has never met anyone who can predict these quick turns in the market on a consistent basis.

Manager's Bio

According to Morningstar, Rice's fund has gained 33% over the past 12 months and 17% annually over the past 10 years, beating the equity energy fund category by 6.5% and 6.7%, respectively.

Rice believes that energy-stock prices will reflect long-term expected prices of underlying energy commodities. And if he is correct in predicting where commodity prices will be, he reasons, his fund should be able to make money in the market.

Barrons.com caught up with Rice to get his outlook on energy prices and a few of his top stock picks.

Q:What price forecast for oil are you basing your investments off today?

A: Longer term, our models suggest that oil prices are sustainable at around $90 a barrel. There will be periods when prices are considerably above that and periods when prices are considerably below that. When prices get much above $90 because of high economic activity, it induces an inflationary impact that knocks economic growth down. When prices are low because of really low economic activity, the lower prices tend to stimulate growth and accelerate the economy, so that they are back up to the level you need for $90.

Q:What does your forecast for oil imply about the progress of the economic recovery?

A: When we do our numbers, we don't think the world can grow much more than 3% a year because it will be limited by lack of available commodities. There may be periods when it grows more, let's say because QE2 [quantitative easing] stimulates the U.S. economy artificially, and the U.S. economy grows at 3% or 4%, and it makes the whole world grow at 5%. We would argue that's unsustainable. That creates a lot of inflation down the road, which will knock the economies down, because there is only 3% available growth in almost all the commodities.

Fund Facts

BlackRock Energy & Resources Fund (SSGRX)

Assets:

$1.8 billion

Expense Ratio:

1.35%

Front Load:

5.25

Annual Yield Portfolio Turnover:

16%

Yield:

0.81%

Source: Morningstar

Q:What do you see happening to natural-gas prices, which managed to miss the recent rally in commodity prices?

A: At $25 a barrel equivalent, natural gas is really, really cheap relative to almost every other energy source out there. Even without government support, that will encourage people to switch whenever they can to use more natural gas, just because there is an economic reason to do it. It would really help if government got behind natural gas and started emphasizing switching, because that would have a life-changing effect on the U.S. economy, but to date that hasn't happened. And your guess is as good as mine why it hasn't.

A: When you say coal you think: Well, I know they are retiring a lot of [coal-fired electric power] plants here in the U.S., and that has got to lead to lower coal demand. Lower demand usually doesn't make for an attractive investment opportunity. But fortunately the rest of the world [is demanding] coal. China and India have coal shortages. The rest of the world is not in good shape coal-wise. Coal is the cheapest fuel out there for the rest of the world. While the U.S. might have low natural-gas prices, the rest of the world prices its natural gas off crude oil. Natural-gas prices in the rest of the world are $9 to $14 per 1,000 cubic feet (Mcf), whereas they are $4 per Mcf here. Coal is at around $50 a barrel equivalent. So the rest of the world, which is growing faster than the U.S. anyway, is using coal whenever it can, and coal usage is up dramatically.

U.S. companies benefit, because we export coal. Up until two years ago, we didn't export. But demand from the rest of the world is pulling coal out of the U.S., and we have the export facility. Last year we exported 60 million tons. This year we'll export 105 million tons, and a couple of years from now we'll be exporting close to 200 million tons. U.S. prices are lower than the rest of the world for coal. The stocks are reflecting U.S. prices, and eventually the stocks will reflect world prices, because they will get dragged out and in the difference between the two, the stocks double.

Top 10 Holdings

(as of March, 31, 2011)

Massey Energy

(MEE)

Consol Energy

(CNX)

Alpha Natural Resources

(ANR)

Peabody Energy

(BTU)

Petrohawk Energy

(HK)

Halliburton

(HAL)

Plains Exploration & Production

(PXP)

Weatherford International

(WFT)

Schlumberger

(SLB)

Arch Coal

(ACI)

Source: BlackRock

Q:Is there one oil and gas stock that you would like to discuss in more detail?

A: Well, let's take
Plains Exploration & Production
(PXP). It has about half of its production coming from California. It is all really low decline-rate production, meaning you don't need to spend much money on it to keep production relatively flat. This is the perfect type of production for a royalty trust that is yield oriented. If the company were to take its California properties, put them in a royalty trust, sell the royalty trust to the public, priced it at what other royalty trusts are priced at in the market today, plus a premium or a discount to get an 8% yield, the value of the company's California properties would be about 50% more than what the stock is trading for. And that's only half their production. Then you have the rest of the company. Half of the company is trading for no value whatsoever.

Q: Is there a natural-gas stock that you would like to discuss?

A: Yes,
Range Resources
(RRC). When the majors are buying companies, they tend to pay a dollar amount on their natural-gas resources (untapped, underground gas deposits) and the going rate so far has been around 40 times an Mcf. On that basis, Range is worth $115 a share. The stock is currently at $53. Real-world transactions value it substantially above where the stock is today.

Most everyone on the Street uses a $70 to $80 valuation for the reserves, which I think severely understates them. The correct number is more north of a $100 a share. The company could be bought out for that, but I think anything above $85 or $90 is palatable to Range management.

You just need an environment where the majors say: I really need a lot of gas, and I have the feeling I want it sooner rather than later. That would come from the Obama administration saying: This is a pretty good idea, and we really should be taking advantage of this gift that we've received from Mother Nature and back out of foreign imported oil. The day after that happens, Shell (RDS.A) comes in and takes out Range. That's how quickly it will happen.

Q:Is there a final stock pick you would like to talk about?

A: My other favorite is
EQT Corp.
(EQT). It's got a huge asset base that's not appreciated by the market and that stock is a 50% to 100% upside from where it is today also.

Q:How is it that your estimates for reserves are so different from the Street?

A: Perhaps we have better information on what they are experiencing for individual well results. We are pretty close to the action with our extensive consultant base. Also, keep in mind that a lot of people on the Street are very today-oriented, and it is hard to be excited about natural gas when natural gas is $4. You just say: Wow, why should I want to own a natural-gas company when prices are so lousy? Then you wake up one day and the company has doubled.

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